The following correction was printed in the Guardian's Corrections and clarifications column, Wednesday November 21 2007

In the above subheading we said "You don't have to be an apostle of old-fashioned nationalism to argue that the state should take control of Northern Rock"; we meant nationalisation, not nationalism. This has been corrected.

A decade of steady growth and financial stability has provided a positive economic narrative for the Labour government and Gordon Brown in particular. The contrast with Black Wednesday and Conservative "boom and bust" has been sharply etched in voters' minds.

The reputation for economic competence was hard won. It is now being lost, very fast. The immediate cause is Northern Rock. I will not rehearse again the arguments about who said and did what to whom and who was to blame for the original crisis. But in extending a loan to the mortgage bank, currently £24bn in addition to the less controversial £18bn deposit guarantees, a series of disastrous errors have been made.

The first was not to demand a clear-out of the senior management which had navigated the bank on to the rocks in the first place. The managers continued with the same business strategy, cheerfully lending on extraordinary multiples of income and loan to value. The cynicism of the chief executive, Adam Applegarth, chronicled in the Guardian, of selling his own shares and splashing out the proceeds on a mansion and a collection of sports cars raises the basic question: why did the government entrust him to manage £24bn of public funds, the equivalent of twice the annual UK primary school budget (or 30 Millennium Domes)?

Second, emergency lending has been advanced at a rapid rate without, it would appear, consistently strong security. As much as £11bn appears to enjoy no security beyond a hopeful expression of faith in the assets of the bank. But half the bank's assets have already been pledged elsewhere (to Granite, an entity with a Channel Islands address), which has packaged up a lot of the bank's mortgage assets. Much of the remaining collateral consists of mortgages that were advanced at the peak of the housing boom and whose value is now in question.

Third, the current process of seeking bids from private interests to take over the bank is replete with conflicts of interest. The Northern Rock directors and managers have a duty to their shareholders and not to the taxpayer. Indeed, they have every interest in maximising government funding and subsidy. The government may have a veto over the final outcome but the public interest has become an incidental byproduct of the negotiations taking place.

As a consequence, neither the chancellor nor the prime minister have been able to give me an unequivocal assurance that the taxpayer's money will be repaid in full, with interest, during this parliament. The likelihood is growing that billions may be lost.

There are now several options for this small, troubled bank. The government hoped that it could be sold to a private bidder, preferably as a going concern, keeping the employment in the north-east, supporting the excellent charitable Northern Rock Foundation and recouping taxpayers' money in full. This hope is now a fantasy. The low bids received make it clear that any serious private bidder will demand large amounts of government underwriting and probably a write-off of some obligations to the government. The more financially plausible bidders would also probably dismantle the bank and take the prize pickings. Strikingly, in the chancellor's "Principles for assessing Northern Rock proposals", the preservation of jobs in the north-east does not even get a mention. The bidders are acutely aware that the government is over a barrel and will extract a high price. Private sale is becoming a deeply unattractive option.

Forcing the bank into administration is a more drastic alternative. The burden would fall most heavily on the shareholders and employees in the north-east. There might also be heavy losses for the taxpayer. Beyond a few Conservative backbenchers few are promoting this option. But it may become increasingly attractive to the government as a way of turning off the tap of public money.

Another possibility which I believe must be seriously considered is for the government to take the bank over, temporarily. It can thereby stabilise the position, avoid being held to ransom by fortune hunters in the City or the shareholders. Public ownership would also create time for an orderly sale, either through flotation or to a mutually assured Northern Rock, operating as it did in happier times before conversion.

Anyone advocating this option can be pilloried, as I have been, as an advocate of old-fashioned nationalisation. I am frequently described as an Orange Book Liberal Democrat, for whom this is an improbable criticism. I don't believe in general that governments should be running banks. But both in the UK and the US this approach has been used before to safeguard the public interest. There are tough options to be faced, and a period of public ownership may be the least worst option available. It is a test of Gordon Brown's and Alistair Darling's political maturity, as well as their financial competence, as to whether they can navigate through this dangerous crisis without ideological preconceptions getting in the way.